Tackling transparency and disclosure through data

The private equity sphere increasingly demands a system that enables the free flow of information from portfolio company level up to LPs. This indicates just how far the industry has come both in terms of LP capital available, and, on the GP side, greater emphasis on technologically strengthened operations.

"I find the challenge intriguing because of my involvement in the late 1990s with FIX connectivity at JP Morgan," says Ed Brandman, CIO at KKR (pictured). "For many of the large LPs, they might be managing 100 GP relationships, and today, as they request information quarterly, there will be some level of push, but an awful lot of pull, and so from an investor relations staffing standpoint, that's challenging. The good news is that there's no real-time nature to this like FIX [in equities], but the same issues apply, just with a different lag. At the end of the day, we would rather be part of the solution, than have it prescribed to us."

LP-GP relationships are not only greater in number but also more important, according to Joncarlo Mark, a co-founder of private equity advisory Upwelling Capital, and previously a senior portfolio manager for alternatives at Calpers.

"In 1999, the average allocation to private equity was 3%; today public plans will be at 10% or even significantly more. For example, Calpers is at 14% and state plans in Oregon and Washington state are all over 20%. So certainly, they have become more in tune with figuring out what they own in a more precise manner, and getting that information delivered to them in a more consistent fashion is critical. This is especially true as institutional investors focus more on measuring risk in their portfolios. In many cases, private equity is bucketed as 'equity' and people are trying to combine their public and private equity exposure to assess their overweights and underweights by sector and geography," he says.

In the past few years, LPs have already begun getting together, hashing out recommendations on reporting templates and valuation processes through industry ventures like the Institutional Limited Partners Association (ILPA) and the International Private Equity and Venture Capital Valuation (IPEV) guidelines. But having achieved much, those initiatives, sources say, are nevertheless too resource-constrained to build the next step: the technology to validate and consume that data.

"Two or three years ago, there would have been zero traction for this," says Stuart Keeler, COO at eFront, a private investment platform provider that, in May, helped officially launch a new industry venture for both discussion and technology development called AltExchange Alliance. "If you look at what firms are already asking for and sharing today – far more than in the past – GPs are potentially producing 20-30 individualised investment packs every quarter, while LPs are receiving those in all different formats. We decided there has to be a smarter way," Keeler says.

Big catcher's glove
Part of what differentiates AltExchange from ILPA is that GPs – KKR and Neuberger Berman, among others – and funds-of-funds, such as Boston-based HarbourVest, are coming to the table along with an array of LPs and advisers. As that group has worked with eFront to develop an XML schema and central validation platform for performance data, a balance of transparency and disclosure was identified as the key issue both LPs and GPs will need to be comfortable with to increase adoption.

"As an LP, you might be invested in a fund, which is part of another fund, that owns a company – in the very least, you want visibility down to what industry it's in, its EBITDA, revenue, and a handful of other metrics," says Karin Lagerlund, managing director and CFO at HarbourVest. "When I started here 12 years ago, our annual report hardcopy was an inch thick, with a page assigned to every partnership. Since then, we've seen an increased focus on confidentiality due to Freedom of Information Act requests after it was applied to private equity in certain states, with sensitivity to what data is passed along, and meanwhile, institutionalisation of the asset class has increased, with the breadth of custodians and administrators that want and track that information really blossoming. GPs seek to provide LPs a high level of transparency while also maintaining confidentiality around private portfolio company information. It's a balance we all still struggle with: how much data can I give out, even on a look-through basis?"

AltExchange's proposed three-tiered schema reflects that concern. "This is about moving away from PDFs toward a genuine data feed for private equity," says Brandman. "Fundamentally, there are two sets of data. One is the standard set of traditional financial reporting, quarterly, on how the fund, its underlying investments, and the related capital calls and distributions that are layered on top of that episodically as they happen. That first bucket is pretty well understood."

The second bucket is more complex, Brandman says: "It concerns information on portfolio companies themselves: sector, underlying holdings, revenue, net debt, capital expenditure spending, and cash flows at the bottom tier-which is enabled by the transformation in the way that information is collected from companies' accounting platforms. How that should be interpreted by an LP, using the same definition for those data elements, is where there is still work to be done."

Upwelling's Mark adds that carried interest and clawbacks taken from the GP, whether they are realized or unrealized; the maturity of the debt and leverage on the portfolio; and even whether loans to the company are recourse or non-recourse-e.g., because of cross-collateralisation-are all pieces of information LPs need to have if they're to properly assess portfolio risk. "This hasn't been tried, and certainly no one wants to spend the energy on the data input. To have the LP be able to operate essentially like a big catcher's glove for data would be phenomenal, and for an LP with three staff managing $6bn, it means far more time available for analysis. You could argue this would benefit the smaller players the most."

Filling the final gap
Deriving the benefits of greater information is the next question – and not just for the smaller LPs. For example, University of Texas investment management company, Utimco, the largest among all public collegiate endowments in the US at $28.4bn, is today collecting about 80% of underlying individual portfolio company risk data, according to its managing director of private investments, Lindel Eakman. That last 20% can make a difference in three ways.

First, Johnny Randel, the CFO for StepStone Group, which advises $50bn in private equity allocations and $10bn directly under management, says that performing cross-GP analytics is an increasingly popular exercise for institutional investors. "As pension plans look to re-up or reallocate, they are increasingly looking to consolidate their capital with fewer, better-performing GPs, which means they need to know which manager is truly delivering value and returns. To properly complete this evaluation, additional, consistent data below the portfolio level is needed," he says.

Brandman uses an example familiar to financial technology to illustrate why the shape of that exercise matters for GPs, too. "SunGard, owned by several GPs, is a good example," he says. "If you're an LP in funds with multiple GPs that all own SunGard, in a perfect world you'd be getting the same data from each of them for performance comparison, and that's not easily done in our current framework. It's about really drilling into the nitty-gritty between GP and LP to say, how do we report this, not only about a given company that's owned, but getting to an agreement to define how assets are held, and accounting for different companies' kinds of investment vehicles – for example, special-purpose vehicles – and GPs potentially entering into an investment at different levels."

Another benefit, Eakman says, is rebalancing an LP's broader portfolio: "Utimco has more than 200 funds and several thousand portfolio companies, and we outsource some of that portfolio data collection to Burgiss, a private investment services provider. Right now, we don't capture every debt-versus-equity detail, which could influence decisions on a potential preferred liquidation, for example. The largest Canadian pension plan has sufficient internal resources that when they get a capital call for an auto dealership holding in China, they'll turn around and sell down similar equities exposure. For me, that is a great example of how a limited partner can benefit from deeper information."

Finally, several sources describe an operationally more efficient and less chaotic reaction to broader economic and geopolitical events. When those events occur, investors want to understand and consolidate their underlying exposure, and therefore risk, within a specific geography or industry at the portfolio company level. "Where that exposure lies has always been important and shortening the time lag to obtaining the most current information is a tremendous benefit to the investor," Randel says.

To read the original article from our sister publication Waters Technology, click here.

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